Wednesday, August 30, 2006

(P.S: Sorry for any disturbances the advertisements above may have caused you)

Main issues

1.Limited growth in medium-term

2.Higher-than-normal future earnings stream risk may not be priced in

The No. 1 market cap stock on the STI and I shall divide a discussion of this stock into the short-term, medium-term and long-term.

Singtel has just gone ex-entitlement (comprising 1-for-20 capital reduction at $2.74) today. Other companies such as SPH and OCBC have undergone capital reductions in the past and have turned out the better for it, which is the reason why the price has held strong today. Besides the higher per share valuation for the capital distribution of $2.74 which limits any big drop by Singtel shares (although effectively the impact is probably only ~1-2 cents since it's a 1/20 reduction), the outstanding share capital has decreased by 5% (ie. 1 in 20) which increases EPS (earnings per share). However the short-term catalyst supporting the price has gone.

Singtel now trades at a trailing PE of ~9.5X and some might see it as a bargain, given its blue-chip status. However, the medium-term and long-term outlook are not exactly rosy. Let's consider the dividend discount model (DDM) for stock valuation:

I'm not even going to try to calculate P through the DDM equation because it's so inexact given that a small change in spread between k and g gives a big variation in final value. However, it's worth appreciating the future direction of these two variables.

Consider the medium-term. Earnings (EBITDA, Earnings Before Interest, Tax, Depreciation and Amortisation) have been split almost evenly between Singapore operations, Australia operations (Optus) and Regional Mobile operations (various associates). The local(Singapore) operations have been stagnant over the last few quarters, with FY06 revenue and profit growth <5% year-on-year -- unsurprising for a mature market with high penetration rate. The Australian arm Optus has run into operational difficulties, experiencing significant EBITDA margin declines of ~5% for FY06 (and dropping further in 1Q07 recently) in another competitive market. The associates in the various emerging markets (Indonesia, Thailand, Philippines, India) have been driving growth recently with about 30% growth rates on average but Singtel has just signalled that any further overseas expansions/acquisitions are not forthcoming, with its capital distribution back to shareholders amounting to $2.3B. We should take this implicit signal seriously. Now, two out of three arms are not expected to have good growth in the medium-term --- that surely does not a buy call make. Overall group operational profit growth has been below 5% and implied value for g, as set out in the DDM equation above, would be very low (given high dividend and capital distribution).

Consider the long-term. The attraction of utilities plays has always been their steady cashflow which is low volatility and hence low-risk ie. implying low k in the DDM equation. Yet consider Singapore. The plan is to build an island-wide broadband infrastructure network (known as the Next Generation National Infocomm Infrastructure) as part of the nation's IT masterplan, which effectively is saying the government is subsidising a plan to erode away Singtel's local competitive advantage. By the time it is complete, voice-over-IP would be mainstream technology and what is Singtel's local competitive advantage but its ownership rights to an incumbent island-wide fixed-line infrastructure? At the same time all telco operators' margins are likely to be squeezed by telco liberalisation which include such moves as portability of cellphone numbers, to name but one of the most significant. In fact, telco operators the world over would be facing such a paradigm shift as convergence of the Internet and telecommunications takes shape, in a manner that will increase unpredictability of earnings going forward (see blog on "The impending decline of telecommunications"). What this means of course is that investors should demand a higher equity risk premium ie. a higher k in the DDM equation.

Lower g, higher k. Qualitatively speaking, Singtel is facing a headwind. And one wonders why they are underpaying their CEO, as reported by the papers (of course, underpaying is a relative word). If I were holding a stock where the potential risk outweighs the potential reward, I would want to sell out too.

Well written, but you forget the massive undervaluation of the overseas stake buys...in the future to me is bright for Singtel. Looking at a 5 yr chart, it augurs 2.85 Hold back your sales I think its premature

I'm pleasantly surprised that this thread has attracted a few readers to give comments. Thanks superman75 for your compliments. Will keep it up !(as I have been doing for a year) To anonymous: I acknowledge that the jewels are the overseas assets. However, waiting for extraordinary gains from their divestment will be basing your exit strategy on hope. In the meantime, one-third of the business booming is hardly great when the other two-third is stagnant or even declining.

To expect strong growth from a company with PE of 9.5x is a bit too much to ask for I think. Such low PE is normally attributed to dividend stocks. If SingTel can just grow 5% each year, I believe it is already hugely undervalued at 9.5x PE.

Hi investsmart,You may note that recently there is talk by Mary Leech (wonder who's that? :-)) of Singtel possibly having to write down the value of its Australian arm Optus. This suggests earnings power is quite weak. If growth of 5% is near-riskless, I think it's probably arguable that Singtel could be a buy. However, note the second part where I argue that its cash streams are also likely to be riskier than before ie. one needs to use a larger discounting factor to discount future income streams. It's all rather qualitative, of course :-)

To borrow a line from a Singapore politician recently: my basic point is reasonable. The recent quarterly results indicate stagnant Singapore and Australia operations -- the mature markets; the growth comes from its associate holdings in the developing countries. However, my call does look bad in the face of the price rally --- I am now fully aware and remorseful over my bad call, insensitivity to the market and lack of empathy for long-time Singtel investors ;-)